Warranties, Neuromarketing, and Neuroeconomics

There’s a neuromarketing lesson in extended warranties. If you have purchased any kind of electronic product in the last few years, you were almost certainly offered an opportunity to extend the product’s warranty. Despite the fact that these are rarely great deals, many people purchase them. Often, the cost of the warranty is a significant percentage of the price of the product itself. Most of the electronic products one finds today have a couple of characteristics – they tend to be reliable, and, when they do fail, they are more or less unrepairable. (A few high-ticket items, like computers, large screen televisions, etc., may not fall into the disposable category.) So why would someone buy a cordless phone for $60 and spend another $20 to extend its warranty for a few years? The answer may lie in neuroeconomics.

The instinct to protect what we have and forgo the obvious benefits of another course is one long studied by behavioral economists. Kevin McCabe, an economist and director of the Center for the Study of Neuroeconomics at George Mason University, said that even without knowing from experience that a product will break, many people insure it anyway.

“I suspect that this behavior is in part due to our sensitivity to uncertainty in general,” he said.

Past discussion here and elsewhere has shown that people will often avoid risk even if the riskier approach is more “profitable” – the brain seems to process the risk information in an emotional rather than a calculating, rational manner. The popularity of extended warranties on throwaway products seems to confirm this – these warranties are a real-world experiment, many orders of magnitude larger than the typical fMRI study. It’s encouraging that the small-scale brain scan studies are consistent with observed behavior of large groups in the real world.

(It’s worth noting that the success of extended warranties isn’t due solely to risk averse behavior – these offers also fall into the general category of post-purchase accessories that enable retailers to boost margins. By offering the primary product at an attractive price, the retailer can get the consumer to decide to purchase it. Then, by offering high-margin accessories at the point when the consumer isn’t inclined to keep shopping at other outlets, the retailer can boost the margin of the total purchase. I’m a veteran of the computer direct marketing business, and for years it was common to see printers selling a few dollars over cost, with much of the margin on the sale coming from the required printer cable. Shipping and handling charges are often similar margin boosters.)

So how should marketers use this knowledge of irrational risk avoidance by consumers? Well, one way would be to keep pushing extended warranties at the point of sale, and pricing them as aggressively as possible. Personally, I don’t like that approach – a firm that sells something of dubious value to consumers may find that practice to be one step in the direction of greater loss of integrity. Rather, savvy marketers should identify where consumers see risk in their product or service, and work to craft a total product package that addresses these risks better than the competition.

Lexus and Risk Minimization. One great example of risk minimization was Lexus in its early days. While it crafted a premium image for itself, and developed a product of high quality, Lexus also addressed those areas of potential risk anticipated by its buyers. Lexus offered a strong warranty like other auto makers, but went further by offering free loaner vehicles and even, in some cases, picking up the vehicle at the owner’s home or office and delivering the loaner. This approach eliminated unpleasant thoughts in the buyer’s mind about having to drive to the dealer, perhaps at an inconvenient time, wait in line to be “written up”, etc. Lexus successfully established itself as a true premium brand, in part due to their high level of service.

In some ways, the Lexus loaner/pickup/delivery offer is similar to the extended warranty issue. The reality is that with these vehicles, the need for service isn’t frequent; the true consumer benefits of the program aren’t huge (barring some unusual service needs). But, the complete warranty and service offering by Lexus in its early years eliminated virtually all service-related risk in the minds of its buyers, and the long-term results speak for themselves.

So, identify the aspects of your product or service that might be perceived as risky by potential customers, and address them in a forthright way – like Lexus, you may end up with high margins, high growth, and long-term success.